Grain Marketing in the Biofuels Era

Session 2: January 29, 2007

Questions and Answers

1)How does margin work for the sellers of options?

The seller of an option faces the similar margin requirements (initial margin and maintenance margin) as the holder of a futures contract and needs to maintain a margin account for their position ( ). As soon as you sell an option, you’ll need to post the initial margin and this will be equivalent to 85% to 100% of the initial margin for the underlying futures contract. This percentage changes every single day, so you’ll need to call your broker to find out what it is currently.

Once you’ve posted the initial margin, your account balance is adjusted every day by the change in the premium of the option. If the account balance falls below the maintenance margin, then you’ll get a margin call. Here's an example: let's say that a farmer sells a Dec07 4.00 call for 40c today. For sake of argument, lets say that the exchange wants a full margin for the short position. So the farmer will have to put up the full initial margin of $1,350. As a side note, you may or may not be credited the amount of the premium received against his margin. So, the farmer has put up $1,350 in margin, and 'received' a premium of $2,000. Now, let's say that the market moves up tomorrow, and the value of the call rises to 43c. The farmer has an unrealized loss of $150 on his position, so he now has a net margin of $1,350-150=1,200, which is above the maintenance level of $1,000. On Monday, let's suppose that the market moves up again, and the option moves to a value of 50c. The farmer has an unrealized loss of $500, so his net margin is now only $850, which is below the maintenance level. He will need to either add $150 in margin to bring his margin position up to $1,000, or close the position.

2)What about a bull spread with calls?

A bull spread with calls is where you combine the purchase of a call that’s in-the-money at a low strike price and the sale of a call that’s out-of-the-money at a high strike price. Here’s an example using options premiums from January 31, 2007, rounded to the nearest cent. You could do a bull spread by buying a $3.50 call and selling a $4.50 call. The $3.50 call premium is $0.60 and the $4.50 call premium is $0.26. We’ll continue to assume that basis is $0.20 under and hedging costs are $0.02 per contract, which will mean $0.04 for a bull spread that uses 2 call contracts. In this case your total premiums= -$0.60+$0.26=-$0.34.

Unless this strategy is combined with a cash sale, there is no minimum price. So in the table we’ve added a $4 cash sale.

Futures / Cash / Buy $3.50 Call, Sell $4.50 Call / With $4 Cash Sale
$3.00 / $2.80 / ($0.34) / $3.66
$3.10 / $2.90 / ($0.34) / $3.66
$3.20 / $3.00 / ($0.34) / $3.66
$3.30 / $3.10 / ($0.34) / $3.66
$3.40 / $3.20 / ($0.34) / $3.66
$3.50 / $3.30 / ($0.34) / $3.66
$3.60 / $3.40 / ($0.24) / $3.76
$3.70 / $3.50 / ($0.14) / $3.86
$3.80 / $3.60 / ($0.04) / $3.96
$3.90 / $3.70 / $0.06 / $4.06
$4.00 / $3.80 / $0.16 / $4.16
$4.10 / $3.90 / $0.26 / $4.26
$4.20 / $4.00 / $0.36 / $4.36
$4.30 / $4.10 / $0.46 / $4.46
$4.40 / $4.20 / $0.56 / $4.56
$4.50 / $4.30 / $0.66 / $4.66
$4.60 / $4.40 / $0.66 / $4.66
$4.70 / $4.50 / $0.66 / $4.66
$4.80 / $4.60 / $0.66 / $4.66
$4.90 / $4.70 / $0.66 / $4.66
$5.00 / $4.80 / $0.66 / $4.66
$5.10 / $4.90 / $0.66 / $4.66

3)How is the “volatility (%)” of the futures market calculated?

Volatility is measurement of the change in price over a given period. It is often expressed as a percentage and computed as the annualized standard deviation of the percentage change in daily price.

4)Is there an on-line (or other readily accessible) source for volatility (%)? If so, where?

The Chicago Board of Trade provides historical volatility by month for each of the commodities that are traded. Go to and click on “Corn”. This will take you to a page of quotes for all of the corn contracts. At the top of the price table, there is a tab labeled “Volatility” which will take you to a table of Historical Volatility for corn.

Corn Futures (C)

5)Do you have any recommendations on finding a good agricultural commodity broker?

Brokerage houses can often differ on the type of services offered. Two general categories exist -- full service brokers and discount brokers.A full service broker will fill orders, offer market analysis, market advice, marketing plans but will have higher commissions. A discount broker will fill orders with no frills and have lower commissions. So the first question you need to ask is if you’re looking for a discount broker or a full service broker. When you’re looking at a broker feel free to ask them for references and also check the broker’s National Futures Registration. ( )

Some questions you may want to ask a broker are:

What is your business philosophy?
What is your educational training?
What relevant experience do you have?
Do you use technical or fundamental analysis?
What is your fee structure?
Do you have the time to answer my questions?
Do you understand my objectives? And will honor them!

The Chicago Board of Trade also has a page on choosing a broker: